Dean Baker is not the kind of guy to use expletives. Tuesday morning he posted, The Problem Is Not the Specter of Deflation, the Problem Is the Inflation Rate Is Too Low. And right out of gate, he wrote, “Okay, this is no longer amusing. Can we stop the nonsense about deflation? It doesn’t make a f***ing bit of difference whether prices are rising at a small positive rate or whether they are falling at a slow rate, except for the fact that the inflation rate is lower.”
I have to admit that this one took me a little while to get my head around. And it was almost certainly Dean Baker who straightened me out about it. The problem seems to be that people think of the inflation rate as some number at which prices are going up. But that’s only true in a statistical sense. Imagine if the economy had only ten products in it — all costing the same amount and representing the same amount of purchases. If six of them went up 10% in price and four of them went down 10% in price, there would be a modest positive inflation. (If my figures are right: 2% inflation.) Now suppose that it was the opposite: six of the items went down in price and four went up. In that case, there would be a modest negative inflation — or deflation. (If my figures are right: -2% inflation.)
Baker’s point is that crossing over the zero doesn’t matter. Having a -0.01% inflation rate is not especially worse than a +0.01% rate — or at least it isn’t any worse than a +0.01% rate is compared to a +0.03% rate. This is actually really important. The reason is that people have this tendency to think that everything is just fine as long as we don’t cross over into negative territory. But the truth is that very low inflation tends to cause economic stagnation just like negative inflation.
I remember many years ago, when I was a libertarian, reading people arguing for the gold standard. (In my defense, I was never keen on the gold standard.) But there was this reasonable sounding argument for why the money supply didn’t need to increase: if the economy grew, the existing money would just grow in value. Wouldn’t you like it if the money in your wallet got more valuable over time?! Well sure. But it would be terrible for the economy as a whole and it would mean a lot of people would be unnecessarily unemployed. If people know that their money is going to be worth more in a year, they have an incentive to put off even necessary purchases.
The same is true if they know their money is going to be worth the same amount. Except, as Dean Baker pointed out, “for the fact that the inflation rate is lower.” And this is the reason that I think the Federal Reserve’s 2% inflation target is too low. I think it should be 3% or even 4%. I don’t have any data to back that up. But neither does the Fed’s 2% target; it is just something that Alan Greenspan pulled out of the air, as far as I can tell. I just think the 3-4% range is low enough that it wouldn’t get out of control, but high enough to keep the economy pumping so that people had jobs.
Regardless, just remember: -1% inflation is worse than +1% inflation — but only in the same way that +1% inflation is worse than +3% inflation. Crossing the zero doesn’t mean anything special. So don’t make this mistake. You’ll make Dean Baker angry. You wouldn’t like him when he’s angry.